Baby On the Way: Are You Ready for Your New Financial Reality?

Dear Carrie,

We're expecting our first child soon and are trying to get financially prepared. We know college is high on the list, but that's so far in the future. What about now? What should we focus on first?

—A Reader

Dear Reader,

Having a baby brings up a lot of financial questions—for the present, for the future, and for all those years in between. Because, no doubt about it, raising a child is a costly proposition. Recent figures from the U.S. Department of Agriculture (2017) estimate it will cost the average middle-income family about $233,610 to raise a child to age 17 ($284,570 if you adjust for 2.2 percent estimated annual inflation)—before college!

Of course, certain expenses such as housing and transportation are part of everyone's budget. And tax law actually includes a few positive items to give parents a bit of a break. But the bottom line is that having kids will likely not only increase your monthly expenses but also shift the way you spend both your essential and discretionary money. While saving for college is a top concern, the sooner you determine the impact of both day-to-day costs and extras—from diapers to daycare to family vacations—the better off you'll be.

Before the baby comes

From everyday budgeting to ongoing expenses, now's the time to do some planning. So sit down together and put some things on paper.

• Review your monthly spending. Estimate ongoing costs for things such as diapers, formula and baby clothes as well as for extras like family outings. If you both plan to work, be realistic about the substantial financial impact of childcare and explore your options in advance. Factor in additional medical costs, both insurance premiums and out-of-pocket expenses. With the numbers in front of you, review your current budget and reprioritize if necessary.
• Update insurance coverage. Health insurance is essential. Whether you have an individual policy or insurance through an employer, make sure you have the best combination of deductibles and coverage. Also consider life insurance, both for a working and a nonworking spouse. Your employer may offer a variety of plans, but an individual or private plan may provide coverage that’s a better fit for your situation. Term policies are generally affordable and provide a high amount of coverage for a low premium over a fixed time frame, say one to 30 years. Get enough to cover your mortgage, debts, childcare, household expenses and your child's education. Also consider disability insurance to cover your income in case you become ill or injured.
• Create an estate plan to protect your child. At the very least, have a will to name a guardian for your minor kids. Without it, the state can choose a guardian. Don't let someone else make this important decision.
• Increase your emergency fund. More things can happen with an addition to the family. Having a bigger emergency cushion can help smooth some of the unexpected expenses that are likely to come along. 

Soon after the baby is born

Even though you'll have your hands full, there are some administrative things you should take care of right away. Decide in advance which one of you will handle them.

• Get a Social Security number for your child. You'll need this to claim your child as a dependent on your income tax return, to obtain medical coverage, and to set up a bank account for your newborn. Provided that you have named your baby, you can generally apply for a Social Security number at the hospital at the same time that you apply for a birth certificate. An application is also available online at ssa.gov, at your local Social Security office or by calling 800-772-1213, but the process is more complicated.
• Add your newborn to your health insurance policy. Do this right away to avoid any delay in coverage. Some companies require you to enroll your newborn within 30 days of birth.
• Check the beneficiaries on your 401(k)s or IRAs. Your spouse is usually the primary beneficiary. You can add your child or a trust for the benefit for your child as a secondary beneficiary. Work with an attorney if you have special assets or specific goals in mind. 

Planning for education costs

It's never too early to start saving for college. Consider opening a 529 account and making monthly contributions. Even a small amount contributed regularly can add up. Plus, earnings grow federal tax-free and there's no tax on distributions if used for qualified educational expenses. Your state plan may have additional tax advantages. A 529 also makes it easy for grandparents, other relatives or even friends to contribute to this important goal.

And under tax law starting in 2018, you can use up to $10,000 a year from a 529 college savings plan for private elementary and high school tuition costs and to repay student loans. Each dollar saved for college is one dollar less you may need to borrow. Be sure to check on state tax laws before opening or withdrawing from a 529. 

Ways Uncle Sam can help

Speaking of tax law, there are a few things you should be aware of and possibly discuss with your tax advisor. On the negative side, because personal exemptions have been eliminated, you can no longer claim an exemption for your child. However, that loss is offset somewhat in a couple of ways.

First, the standard deduction has effectively doubled to $12,400 for single filers and $24,800 in 2020 for married filing jointly. That amount may be more than the combined personal exemptions for your family would have been under the old tax law.

Also, the Child Tax Credit (CTC) has increased from $1,000 to $2,000 per child. Plus, $1,400 of this credit is refundable, which means even if you don't owe any income tax, you could get a $1,400 refund. Another bit of good news is that while eligibility for the CTC is tied to income, those levels have been raised considerably to $200,000 for single parents and $400,000 for married couples. 

Taking care of yourself

Lastly, don't forget your own financial needs. Keep contributing to your 401(k) or IRA. Prioritize savings to include other long-term goals like buying a house or taking a family vacation. And while you're at it, remember to put aside a little for some personal R & R. A night out once in a while can be a welcome break—even if you spend most of the time talking about the new little person in your life.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.